Our hugely progressive tax code

A newly-released study by the Congressional Budget Office was designed to demonstrate that the inequality of income distribution in the U.S. has declined in recent years, thanks to increased transfer payments and higher tax rates on the rich. As Mark Perry notes, "Almost half of the income inequality between the highest and lowest household quintiles disappears when we adjust for government transfer payments and federal taxes. Before taxes and transfers, the average income of a household in the top 20% is 15.1 times greater than the income of a household in the lowest quintile, but that ratio drops to only 7.8 times after adjusting for transfers and taxes."

Reasonable people can disagree about whether a reduction in inequality achieved in this manner is a good thing or not (I'm in the disagree camp). In any case, the U.S. income tax code remains highly progressive, especially when one factors in the effects of income redistribution. That's illustrated in the chart above, which shows the percentage of total federal taxes paid divided by a comprehensive measure of income which includes labor income, business income, capital gains realizations, dividend income, and retirement income, plus all government transfer payments. The bottom one-fifth of income earners pay an average federal tax rate of only 2%, whereas the top 1% face an average federal tax rate of almost 30%. It's much worse in states like California, where top income earners also face a state income tax rate of 13.3%. Moreover, rates in the charts above for "the rich" would be higher today, thanks to a new top federal income tax rate of 39.6%, and an additional medicare tax of 0.9% for couples earning over $250K.

Mark also notes that because of the relatively high level of transfer payments these days (which are now at all-time highs relative to disposable income), well over half of all taxpayers receive more in transfer payments from government sources than they pay in taxes. That's illustrated in the chart above, where each bar represents the average household income in each quintile minus government transfers received. Furthermore, Mark notes that "the top 20% of American “net payer” households finance 100% of the transfer payments to the bottom 60%, as well as almost 100% of the tax revenue collected to run the federal government."

The chart above tells the same story, even though it is more narrowly focused, since it excludes employment taxes, business income, and transfer payments. It looks only at the percent of total federal income taxes paid by the 25% of income earners. Here we see that the top 25% of income earners pay almost 90% of federal income taxes.

How can anyone argue that the rich aren't paying their fair share? A great majority of the people are net recipients of the money paid by a relatively small majority. If anything, we have a potentially destabilizing situation, in which a large majority receive much more from the government than they pay in, and they can vote themselves still more of the money earned by a small minority. That's a classic "tyranny of the majority."

Supply-siders have argued for years that the steeply progressive U.S. tax code, with its myriad deductions, transfers, and subsidies, is extremely inefficient, and anti-growth. It's a major headwind to economic progress, and it most likely hurts the very people it's purportedly designed to benefit: the middle class. Why? Because the U.S. economy is arguably missing out on some $2 trillion each year in income—most of which would likely accrue to the middle class—because of, among other things, very high marginal tax rates and extremely burdensome regulations that discourage work and inhibit new business formation.